Corporate governance has over time moved from being a peripheral to a central issue for capital markets regulation. Our recent research focuses on how that transformation has occurred in the UK and how it has adjusted the default provisions of UK corporate law.
We begin with the observation that corporate governance was not a significant concern for listing rules in the UK for most of the twentieth century. That broad trend, evident also in the US, albeit with some timing differences, can be attributed to two factors: the key focus of early securities regulation on disclosure as the primary technique for investor protection; and the phase of so-called “managerial capitalism” during the postwar years, in which shareholders adopted a largely passive stance towards the running of listed companies. The emergence of “corporate governance” as a discourse and practice represented a change of focus in which shareholder interest came more directly into focus in terms of its links to the structure, composition, and decision-making of the board of directors.
We approach the relationship between listing rules and corporate governance by focusing on three key interactions. The first is the interaction between listing rules and the UK Corporate Governance Code (UKCGC). The second is the impact of listing rules on the balance of power between shareholders and directors. The third is the impact of listing rules on the role of controlling shareholders and the protection of minority shareholders. Whereas the first interaction implicates the role of soft law codes in the UK and other systems which have followed that approach, the second and third interactions run parallel to the corporate law focus on agency costs – as between shareholders and directors and between majority and minority shareholders respectively.
Over time we observe an increasing link between the UK listing regime and corporate governance standards. The emergence of the UK Corporate Governance Code (UKCGC) and its incorporation as a disclosure rule into the listing regime resulted in a more substantial and wide-ranging focus on corporate governance standards. The linkage between hard and soft law represented by that process reflected the self-regulatory origins of the Code and by implication the influence of institutional investors. The overall effect for premium listed companies has been to require higher standards of corporate governance by comparison with the minimal requirements of UK company law. But it also seems clear that the objective of providing flexibility in governance through the Code has been frustrated by a tendency towards simple compliance, which has constrained the use of the “explain” option in connection with alternative governance arrangements. Meanwhile, accountability to investors has suffered due to poor quality “non-compliance” explanations, as valid reasons are not provided when alternative arrangements are adopted. In principle, the “comply or explain” approach left considerable flexibility in governance to listed companies, but experience indicates that little use has been made of that option because simple compliance has become widespread. In that sense, the salience of “comply or explain” as a concept has been eroded and with it the sense that market discipline would be the primary disciplinary mechanism in demarcating a legitimate space for the operation of governance structures and processes that deviated from the UKCGC.
We then consider how governance provisions in the UK listing regime alter the balance of power between shareholders and directors. In common with some other countries, the UK is generally characterised as adopting a shareholder primacy stance in this context. This is evident in UK company law in the form of strong powers of dismissal and the reservation of a range of decisions to shareholders which have the effect of diluting the broad default powers of directors in the standard articles of association. The UKCGC represents another step in that process through its control of the structure and composition of the board of directors. The principal techniques are the requirements relating to independent non-executive directors (INEDs) and their role on three key subcommittees of the board. These requirements amplify the influence of shareholders relative to executive directors by implementing the “monitoring” model that has long been associated with INEDs and allocating key decisions to subcommittees with a majority of INEDs. We also note that the tendency to expand shareholder oversight is evident in the listing rules on approval rights for significant transactions and share issues without pre-emptive rights. These interventions have the effect of cutting back the broad default powers given to directors in corporate law by limiting the authority of directors to significantly change the nature or scope of the business without shareholder approval.
Finally, we evaluate the implications of three aspects of the listing regime that are linked to concerns over the potential abuse of the powers of controlling shareholders and the protection of minority shareholders. While equality between shareholders of the same class has been a longstanding principle of the listing rules, minority shareholder protection has not been a major concern. Two reasons largely explain that outcome. The first is that UK company law has relatively strong minority protection provisions. The second is that share ownership in the UK market has tended to be relatively dispersed and therefore the potential concerns that might arise from the presence of controlling shareholders in listed companies were generally not present in the UK.
The provisions of the UKCGC on the composition of the board and the appointment of the chair insulate the operation of the board to some extent from the influence of a controlling shareholder. At least half the board, excluding the chair, should be non-executive directors whom the board considers to be independent. The chair should be independent on appointment and the roles of chair and chief executive should not be exercised by the same individual. Moreover, independence in this context encompasses, inter alia, representing a significant shareholder (a lower threshold than a controlling shareholder).
So far as the listing rules are concerned, regulation of related party transactions did address concerns over the abuse of power even if they are arguably set at too low a level and are engaged by relatively few transactions. Minority protection became a more prominent concern as companies with controlling shareholders (particularly in the mining sector) were attracted to list in London and attention focused on the potential abuse of majority voting power. Changes were made to the listing rules in 2014 to address this issue. Controlling shareholder agreements and the related disclosure of compliance offered some potential for control over abuse of power, albeit that the overall impact is hard to assess. More recently, minority protection concerns were triggered by the global rise of so-called “dual class” share structures, which provide for enhanced voting rights for different classes of shares, often with the objective of preserving the control of founders following a public offer. Ultimately, the UK policy of resisting dual class shares was relaxed on the basis that it was necessary to protect the global competitive position of the UK capital market. The limited adoption of dual class share structures arguably moves the UK listing regime in a different direction by permitting more effective control by controlling shareholders in the form of founding directors. Nevertheless, since the evidence from other systems does not link those structures clearly with a reduced level of minority protection, it would be premature to claim that this development runs contrary to the general trend in the UK towards strong minority protection.
In overall terms, the linkage between the UK listing regime and corporate governance standards is substantial. In that sense the claim that listing (including cross-listing by overseas companies) represents a form of “bonding” to higher corporate governance standards seems correct. It is more difficult to evaluate the drivers for establishing the appropriate balance between disclosure and governance standards in the listing regime. It may be that the increasing engagement by the listing regime with “governance” recognises the decreasing marginal utility of expanding disclosure obligations, which can inform market pricing of securities but do not provide a conduit for shareholders to use their voting power to influence decision-making. The increasing role of stewardship in corporate governance adds another dimension to the respective roles of disclosure and governance as it opens up the potential for informal influence at an earlier stage than voting on formal resolutions. Meanwhile, the relative position of the UK versus other systems is likely influenced by its tendency towards shareholder primacy in corporate law and investor empowerment in corporate governance and capital market practice. Thus, while the UK presents an interesting case study, its relevance for other systems should be understood with those caveats in mind.
Iain MacNeil is the Alexander Stone Chair of Commercial Law at the University of Glasgow.
Irene-marié Esser is Professor of Corporate Law and Governance at the University of Glasgow.
This post is adapted from their paper “Capital Markets and Corporate Governance Standards” available on SSRN.
The views expressed in this post are those of the authors and do not represent the views of the Global Financial Markets Center or Duke Law.